Options Part III - The Downside
In my first two blogs of this series, part I and part II, I explained the good side of options. Basically, a high percentage return in a short amount of time. However, as promised, today I'm going to get into why some people choose to stay away from options, and how options are severely disadvantaged to stocks.
Options have one major factor working against them, and that's time decay. Not only do you have to be right about what a stock will do in the future, you have to be right about how quicky it will move as well. If you are wrong, you will lose your entire investment, which makes options trading a very risky venture.
For example, say that I think Google (GOOG) is going to make a major move up in the next 6 weeks. Today Google closed at $293. In my research, let's say that I've concluded that Google could rise to $330 by July 15th. I might buy the July 2005 call with the strike price of $300 for $13.85 per option. If I buy one contract (100 options) I will have an initial investment of $1,385. This gives me the right to buy 100 shares of Google stock for $300 at any time until and including July 15th, 2005.
If Google does what I think it will, and rises to $330 on July 15th, I will make $30/share ($30 * 100) = $3,000 - $1,385 (the premium to buy the options). This gives me a profit of $1,615 in 5 weeks on a $1,385 investment.
But, suppose I'm wrong! What if Google goes sideways until August and then decides to move up. I'm plain out of luck! My options expire on July 15th, if the stock hasn't made the predicted move by then I'm out my entire investment, because my options will expire worthless. I will lose $1,385.
If I had bought stock today instead of options expecting the same rise by July 15th, I could always hold onto the stock and give it more time if the stock didn't perform as well as I hoped. I wouldn't have that power with options. This is where time decay really comes into play, you are racing against the clock with options.
This is the reason why many people (including myself) don't play options this way. I paper traded options for about a year and was only right about 1 out of 10 times. The 9 out of 10 times I was wrong more than offset the amount I made when I was right. For this reason, every options trade I've done for almost a year now has been a spread, or some variation of a spread. A spread, which I will talk about in my next installment, puts time on your side when making your options plays.
• VirtualBank gives you up to 5.13% APY for your savings!
• Blue Cash from American Express: 5% Back on Gas, Up to 5% cash back on eligible purchases, No Annual Fee, 0% Introductory APR for 6 months, Pay over time
• Try Starwood Preferred Guest Credit Card from American Express. Great rewards and first year fee free!
• Bad Credit Home Loans
• Life Insurance in 10 minutes if qualified. No medical exam.
In yesterday's blog I gave a brief introduction to what stock options are. I also gave an example of both a winning options play and a losing one, and the result of each scenario. Today I'll touch on some of the reasons people find options ... Read
If you are like most people, you have heard of options but don't know exactly what they are. Of course, this being a personal finance blog most of the readers are a bit more savvy, however I will start out this multi part series on ... Read
One of the reasons people trade options is because of leverage and affordability . 100 shares of google at $293 per share is $29,300 a lot of people dont have that . A lot of people also trade on margin and I think you can lose a lot more more a lot faster trading on margin . one might one to but out the money leaps or calls that are many months out . Recently google went from $180 to $299 . In April when google was in the $180,s the June 240 call was about 50 cents now that call is about $50 . Trading options should be one of your investment vehicles
